Hybrid funds continue to evolve
As companies stay private longer, hedge fund managers want to be positioned to capture some of the alpha opportunities earlier, before the companies go public. They find that knowing about the companies earlier, informs their views and makes them better investors. It also diversifies their business and revenue sources.
If hedge funds invest in illiquid products, they run the risk that if some investors redeem, than those investors that don’t redeem have a disproportionate exposure to illiquid assets. At the same time, side pockets have fallen out of favor with investors.
Hybrid structures have evolved that offer more ability to match liquid funds to the underlying liquid portfolio. To take advantage of illiquid opportunities, hedge fund managers can take a number of approaches. Seward and Kissel's Kevin Neubauer lists a few:
1. An equity fund with two portfolios - a public portfolio for liquid securities and a private equity portfolio for illiquid investments.
2. An evergreen fund that has restrictive redemption terms. For example, some of them pay out redemption proceeds using a “liquidating account” mechanism causing redeemed investors to not receive redemption proceeds attributable to a particular asset until the fund sells that asset. This allows managers to not have to manage the portfolio to meet redemption requests.
3. On the credit side, the manager’s launch looks like a private equity fund – the investor makes contributions and the GP draws down all capital on Day One. It looks like a private equity fund but operates like a hedge fund.
Some managers are launching dedicated private funds. James McElroy at LCG Associates, observes that many of their investors don’t want a side pocket and prefer to keep their public markets and private markets investments separate. It is also a way for traditionally labeled public markets firms [and hedge funds] to expand their investor bases and benefit from longer term capital.
The hybrid trend is seen most often with managers, who trade equities and specialize in healthcare or technology sectors. They may find opportunities in late stage or pre-IPO companies. It also appeals to activists, opportunistic managers, and credit strategies where assets can be valued but investments are not liquid, as well as catalyst-driven strategies. Credit managers with evergreen structures and those with loan-originating funds can use the hybrid approach.
Excerpt from just-released white paper. For more info: [email protected]; 212 689 0180.
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